Economic Systems SSEF4

Overview Every society must contend with the problem of scarcity. Every society, regardless of its political structure, must develop an economic system to determine how to use its limited productive resources to answer the three basic economic questions. What goods and services will be produced? How will goods and services be produced? Who will consume the goods and services? The way a society answers these questions determines its economic system.

Types of Economic Systems Three types of economic systems exist to answer these questions. Traditional – In a traditional economy, economic decisions are based on custom and historical precedent. Command – In a centralized command economy, government planning groups make the basic economic decisions. They determine such things as which goods and services to produce, their prices, and wage rates. Market – In a decentralized market economy, economic decisions are guided by the changes in prices that occur as individual buyers and sellers interact in the market place (which it is also referred to as a price system). Other names for market systems are free enterprise, capitalism, and laissez-faire.

Mixed Economies There are no pure command or market economies. To some degree, all modern economies exhibit characteristics of both systems and are often referred to as mixed economies. However, most economies are closer to one type of economic system than another.

Market Economies Market economies rely primarily on the price system to answer these questions. For example, suppose a new craze for tennis results in consumers purchasing more tennis rackets. If this is the only change in the market, the increase in demand for tennis rackets will cause their price (the amount people pay when they buy a good or service or the amount they receive when they sell a good or service) to rise, resulting in more profits for producers of tennis rackets. The rise in profits will encourage existing producers to make and sell more rackets. It will also encourage new racket producers to enter the market, encouraging competition from new businesses (an organization that produces or exchanges goods or services for a profit). Eventually, the supply of tennis rackets will increase and the price will fall.

Comparison of Economies Economic systems are those institutional frameworks of formal and informal rules that a society uses to determine what to produce, how to produce and for whom. Economic systems can be categorized according to who makes most of the decisions in an economy.

Comparison of Economies In a market economy, most of the decisions in the economy about what to produce, how to produce it and who receives it are made by individuals and firms.

Comparison of Economies At the other end of the spectrum, in a command economy, government officials make most of the decisions in the economy about what to produce, how to produce it and who receives it.

Comparison of Economies Most economic systems also contain elements of tradition or repeating decisions in ways made at an earlier time or by an earlier generation. Most economies are mixed in that some economic decisions are made by individuals and private firms, but some are also made by government officials, either through rules and regulations or through government- owned firms.

Comparison of Economies The U.S. economy leans toward the market-oriented side of the spectrum. An economy like Cuba or North Korea is near the command economy side of the spectrum. But the dividing line between market and command economies in most nations is blurry rather than bright.

Command (Centralized) Economy An economy in which most economic issues of production and distribution are resolved through central planning and control. Market (decentralized) Economy An economy that relies on a system of interdependent market prices to allocate goods, services, and productive resources and to coordinate the diverse plans of consumers and producers, all of them pursuing their own self-interest. Mixed Economy There are no pure command or market economies. To some degree, all modern economies exhibit characteristics of both systems and are, there, referred to as “mixed”. Profit Motive The desire to make money which motivates or causes people to work hard to produce goods and services. Consumer Sovereignty The extent to which people are free to choose in the marketplace without government regulation Competition Attempts by two or more individuals or organizations to acquire the same goods, services, or productive and financial resources. Consumers compete with other consumers for goods and services. Producers compete with other producers for sales to consumers. Governmental Regulation The extent to which government intervenes in the decisions of buyers and sellers in a market

Market Economy An economy that relies on a system of interdependent market prices to allocate goods, services, and productive resources and to coordinate the diverse plans of consumers and producers, all of them pursuing their own self-interest.

Mixed Economy There are no pure command or market economies. To some degree, all modern economies exhibit characteristics of both systems and are, there, referred to as “mixed”.

Profit Motive The desire to make money which motivates or causes people to work hard to produce goods and services.

Consumer Sovereignty The extent to which people are free to choose in the marketplace without government regulation

Competition Attempts by two or more individuals or organizations to acquire the same goods, services, or productive and financial resources. Consumers compete with other consumers for goods and services. Producers compete with other producers for sales to consumers.

Government Regulation The extent to which government intervenes in the decisions of buyers and sellers in a market

Economic Freedom The freedoms of the marketplace the freedom of consumers to decide how they wish to allocate their spending among various goods and services the freedom of workers to choose to change jobs the freedom of individuals to establish businesses and to decide what to produce and when to change their pattern of production the freedom of savers to decide when and where to invest their savings.

Economic Security Protection against economic risks, such as unemployment, accidents on the job, business failures or natural disasters, over which people have little or no control. Economic security refers to protecting consumers, producers, and resource owners from risks that exist in society. Each society must decide from which uncertainties individuals can and should be protected, and whether individuals, employers, or the government should provide or pay for this protection.

Economic Equity The application of our concepts of what is "fair" or "unfair" and what is "right" or "wrong" to an economic policy. Ultimately deals with the distribution of income and wealth. Some people judge equity based on providing equal opportunity. Others judge based on equality of outcomes.

Economic Growth Increasing the production of goods and services over time. Economic growth is measured by changes in the level of real gross domestic product (GDP). A target annual growth rate of 3 to 4 percent in real GDP is generally considered to be reasonable and sustainable.

Economic Efficiency A situation in which no one in a society can be made better off without making someone else worse off. The gains for society must be more than the costs to that society. Economic efficiency refers to how well scarce productive resources are allocated to produce the goods and services people want and how well inputs are used in the production process to keep production costs as low as possible.

Economic Stability This is the process of maintaining stable prices and full employment and keeping economic growth reasonably smooth and steady. Price stability means avoiding inflation or deflation. Full employment occurs when an economy’s scarce resource, especially labor, are fully utilized.